Identify Your Profitable Customers (And Who's Making You Lose Money)
In most companies 15-20% of customers generate almost 100% of profits. So, what about the rest of them? Find out if your customers are actually making you lose money by developing key metrics to measure your customer profitability.
Have you had the case where increasing your client base or revenue per customer did not increase your net profits (or worse, it decreased them)? Many companies go out of their way to delight their customers and increase their client base. Yet, by doing so, they may end up offering special product features and services whose costs are not covered by the price paid by the end customer.
What can companies do to prevent this from happening? Incorporate a customer profitability metric into their BSC.
For many companies it is difficult to know exactly how much each customer is costing them in marketing, distribution, SG&A, and other costs. The most accurate way to allocate these costs is, in many cases, through activity-based costing (ABC). Nevertheless, when trying to implement this methodology, many companies have found that it is not adaptable to their complex business, that its implementation takes too long or that it is too expensive. There is, however, a new and simpler approach to cost allocation: “time-driven ABC”.
This approach requires calculating the cost per hour for each department or service group and how much time is invested in each customer per service. By comparing these two concepts companies can more easily identify customers that are not profitable. For example, if your customer support department averages a cost of $70 per hour and a specific customer transaction requires 24 minutes, the cost of the transaction equals $28. It is, therefore, simple to calculate if the incremental value generated by the customer is enough to exceed the cost of creating and delivering said differentiation.
Measuring Customer Profitability with the BSC
Implementing this metric will allow the company to accurately know how profitable each one of their customers is. It will also help make the point that increasing, satisfying and retaining customers is only desirable if they contribute to higher profits. This way, the company will go from being customer-obsessed (wanting to satiate their every needs, even if it meant losing money) to being customer-focused (intending to turn a profit by selling products and services).
When identifying low-profitability customers, the company should first look internally if there is a way it can make its processes more efficient, so as to decrease its cost-to-serve (for example, by taking advantage of Web-based solutions so customers can place their own orders). Another solution the company could implement is to set a base price for its services or products and charge an extra for special customizations (making sure this, at least, covers the cost). Finally, the reason the customer is unprofitable may be because it is consuming a single product or service. Therefore, by cross-selling an array of higher-margin products to the customer, the company can hope to turn it into profitable. However, if the company is unable of turning these accounts profitable, it would be advisable to drop them.
Similarly, this method allows companies to focus on building its high-profitability customer loyalty, increasing its retention rates and generating more business from them.
Using this metric does not only help executives better understand the link between customer success and financial performance; it ultimately helps the whole company understand their business and customers better and work to optimize their client bases. This way, executives can focus on managing their customers for their profitability instead of for their sales volume, therefore making sure that each new customer is beneficial for the company.
At TRISSA we can help you all the way
The market is constantly changing. We see successful companies arise, as well as many not-so-successful ones sink, every day. In this make-or-break economy, how will your organization perform?
At Trissa we provide our clients the tools and expertise needed to help them clarify their strategy, translate it into operative terms, align their organization and establish an effective follow-up mechanism to guarantee its successful execution.
So go ahead, browse our webpage and get to know us better. Or send us an e-mail; our consultants would be delighted to answer any questions you may have: firstname.lastname@example.org
Source: Robert S. Kaplan